Does Dynamic Investment Theory Really Change Investing at a Fundamental Level?
Yes, It Does!
On this site I describe a fundamentally new approach to investing called Dynamic Investment Theory (DIT) and the new investment type that DIT creates called Dynamic Investments (DIs). DIs produce returns that today's financial experts will say are impossible. And skeptics are coming out of the woodwork.
As a trained scientist I would be skeptical, myself, of the claims that are made on this site. When reading that DIs are capable of consistently producing returns that are multiple times higher than traditional MPT portfolios with less risk and no active management, my first reaction would be: "What kind of scam this is?"
So it is my task on this page to address the skepticism that I deal with virtually every day related to DIs and to convince you that the results shown and the claims made on this site are real. To be credible, I must show to you that these results are based on a solid foundation of logic, statistically significant empirical observations and the use of scientific methods in the DIT development process. I need to demonstrate to you this is not a scam or a trading system but rather a fundamental change in how we invest today that has worked in the past, works today and will continue to work in the future.
Any site that claims to have made this type of change in the art and science of investing must have a page like this. If it doesn't, its probably because it can't. Let's begin.
Why People Are Skeptical
First, let's look at why Dynamic Investment performance brings out the skeptic in people. I presented the below performance table first on the home page of this site. The performance data presented for the NAOI Basic Dynamic Investment, shown on the top row seems too good to be true. Let's look at it again. Shown on the top row are yearly returns of the DI for the past 10 years along with the Average Annual Return and Sharpe Ratio - a measure of how much return is gained for each unit of risk take. The bottom data row shows the same information for a standard portfolio created using standard Modern Portfolio Theory (MPT) methods with the allocations shown. You can see that the DI returns are "off-the-charts" superior.
The DI returns are like nothing we have ever seen in the world of investing. That is why I am constantly assaulted with questions and doubt similar to the ones I present below on this page.
Performance Like This Is Impossible !
The only way to get a performance leap such as that shown by the DI in the table is by changing the fundamental level way we invest today. MPT designed portfolios can't produce returns like these. But DIT designed investments can. A major problem with current investing methods is that MPT methods were introduced in 1952 when markets were a far different place. Markets have evolved significantly since then but MPT hasn't changed at all; and it no longer works in today's markets.
DIT was designed by the NAOI to not only work in modern markets but to take full advantage of their volatility. While MPT insists that a portfolio own both winning and losing equities at all times, DIT is designed to hold ONLY winning equities while avoiding losing equities. This is done through the use of a new diversification element called Time-Diversification provided by a buy-and-sell strategy. You can read more about Time-Diversification at this Blog Post.
Is DIT a Trading System? - NO!
I have had people tell me that DIT is nothing more than a "trading system", one that may work for a short time and then doesn't. There are a lot of trading systems out there but DIT isn't one of them. DIT is a fundamentally better approach to investing developed based on years of scientifically based research and development. NAOI research showed that the DIT-based approach worked in the past, that it works now and that it will continue to work in the future. Go to this link to read the definition of a trading system. You will see that DIT does not fit this description at all. DIT is an evolution of MPT - which we can all agree was not a trading system but rather a valid theory of investing.
DIT Is a Scientifically-Based Theory of Investing
In 2008 when the NAOI started looking for a more relevant theory for portfolio design, we vowed to find one that was both theoretically as well as empirically sound. In other words not only must it be logical it must produce consistently superior results. This goal mandated that our development efforts be based on scientific methods. And it was. Following are the steps we took in the development process along with links that explain each term - shown in blue.
1. Goal Definition: Our first task was to define an unambiguous goal for a new approach to portfolio design and investing in general. Our goals included making the investing process simple, more profitable than current methods and with low risk. None of these goals are met by Modern Portfolio Theory (MPT), today's standard approach to investing, a topic discussed at this link.
2. Define a Premise - All scientific methods start with what we know about the issue being researched, in this case how equity markets work. We found that the ONLY thing we know about equity markets today with a high degree of probability is that they are cyclical in price and that different assets, markets and market segments move up and down in price at different times. And, as a result, there exist positive returns somewhere in the market at all times and in all economic conditions.
3. Create a Hypothesis - Based on our premise we predicted that an investment type could be created that was capable of searching for, finding and capturing the positive returns that the market offers at all times while avoiding areas of the market that were trending down in price. This was our hypothesis and another critical element of the scientific process.
4. Hypothesis Testing - We next built a series of investment prototypes to try to prove our hypothesis. We tested each model extensively, looking for one that could consistently and significantly outperform MPT portfolios in the same set of economic conditions. We found it in the form of Dynamic Investments that are described here on this site. The performance of the simplest "Basic" Dynamic Investment is shown in the table at the top of this page.
5. Create a Theory. Empirical observation of the Dynamic Investment structure showed us that this investment model could, with a high degree of probability, meet the goals we set in Step One, above. We had validated our Hypothesis and could then label it as a working Theory that we called Dynamic Investment Theory (DIT) that is discussed at this link.
Dynamic Investment Theory sets forth the logic and rules for creating Dynamic Investments. The Basic DI illustrated in the table above is only one example. The theory allows for the development of an unlimited number of DIs and for an unlimited number of combinations of DIs in DI portfolios discussed here. And anyone who reads and understands Dynamic Investment Theory can create their own unique DIs. The fact that our discovery of this Theory enables anyone to repeat our success at creating investments/portfolios that are far superior to MPT portfolios is a requirement of any valid "theory."
The bottom line is that we had developed a theory of portfolio design, and investing in general, in the form of Dynamic Investment Theory that could finally evolve Modern Portfolio Theory from the 1950's to the 21st Century.
Where Is the Market Analysis?
A major factor in making equity purchase and trade decisions today is market analysis. If you have read on this site how Dynamic Investments work (see here) you may be asking yourself where is the market analysis in the creation and management of Dynamic Investments? Well, it's there but not in the form you are used to.
Today market analysis is done by financial mavens who make recommendations based on subjective human judgments. The NAOI didn't believe that this was good enough. We saw human analysis and predictions of market movements to be little more than "informed guesswork" and vowed to get rid of this risk factor.
Market analysis in the DIT process comes in the form of objective observation of empirical market trends. there is no guesswork here. DIs buy and trade equities based on the strength of their price trends - it is that simple. Purchases and trades are not based on trying to analyze dozens, even hundreds, of factors that may effect market movements. All of these market factors are "baked in" to an equities price and its trend. We saw no need for human analysis to try to second-guess the market.
DIs are the market's first active investment that is passively managed and history has shown that passive management consistently produces superior results to those that are actively managed. Read this Blog Post for further discussion of this topic.
What About the Tax Issues of Trading?
Skeptics tell me that NAOI Dynamic Investments won't work because the frequency of trading triggers short-term capitol gains taxes that nullify any gains earned by trading. But this is false for the following two reasons.
- DI Gains Dwarf Additional Taxes. The performance of DIs using a buy-and-sell strategy is so superior to that of static, buy-and-hold MPT portfolios that the marginally higher taxes related to short-term gains are dwarfed by the higher returns generated by DIs. Even after short-term gains taxes are deducted, DI returns beat MPT portfolio returns every time - and not by just a small amount. For proof of this refer again to the table at the top of this page.
- Investing in Tax-Deferred Accounts. Most investing by the public today is done in tax-deferred accounts, such as IRA's and 401(k) Plans. in such accounts, gains are are taxed at personal income rates when money is withdrawn at time of retirement. Thus for the majority of individual investors there is no tax penalty for the short-term trading used by Dynamic Investments. In fact, the full power of retirement plans is not exploited unless an investor does buy and sell equities to take advantage of market movements as there is no tax penalty for doing so.
Taxes are NOT a reason to forego the benefits of using NAOI Dynamic Investments. It's not even close.
Isn't Frequent Trading Is A Bad Idea?
We have been taught for decades that no one is smart enough to "time" the market in order to make successful trades. Here's why this argument is true but moot in the world of Dynamic Investments:
- Humans Can't Time Markets - But "Markets" Can. It is true that frequent trading by human analysts is usually not a good thing. There are just too many variables to work with. But with DIs, humans don't make the trading decisions - the "market" does. And virtually everything known about an equity is factored into an investment's price and trend. Testing and empirical observations show that "the market" is a lot smarter and far more successful at predicting future market price movements than any one, or group, of human analysts. So, yes, DIs can effectively "time" the market while the NAOI agrees that humans can't.
- Additional Trading Costs. And, of course, some will try to say that the trading costs involved with the buy-and-sell strategy used by DIs are excessive. Maybe back in the day when advisors charged $75 per trade this argument had some validity. Today, using an online broker, trades cost about $7 each. And using Dynamic Investments trades are rare. For the NAOI Basic DI illustrated in the table above that earned 30% + per year from 2007 to 2016, there were only, on average, a little over 4 trades per year (a buy and a sell for each time the ETF was changed). Using an online broker this would cost about $30 per year - an insignificant amount compared to the resulting superior returns.
The utter disdain that the financial services industry has today for a buy-and-sell strategy is based on thinking from the 1950's when MPT was introduced. Modern tools make buying-and-selling not only easy and inexpensive but also essential to take full advantage of the gains that are available in today's volatile markets.
Why Has MPT Lasted for 65+ Years?
Modern Portfolio Theory has been the "settled science" approach for portfolio design since 1952. If it is such a disaster why has it survived so long?
In my opinion it is not because MPT is the best approach available. Rather, it is because it forms the foundation of a multi-billion dollar financial services industry. The MPT approach is so confusing, filled with variables and rife with subjective human judgments that individuals can't navigate the world of investing on their own. Thus, they have little option but to just buy what their advisors recommend without question and hope for the best. And this makes today's MPT-based financial industry very rich.
On this site I am suggesting that the industry's MPT "goose that laid the golden egg" be replaced with DIT that is far easier for individuals to work with and decreases dependency on financial advisors. As a result, many organizations will ridicule what they read on this site.
Due to the fact that even the simplest Dynamic Investment, as illustrated at the top of this page, outperforms the most sophisticated MPT portfolios, the skeptics will attack this superior approach with all they have. (See the quote at right.) And these attacks will be based primarily on selfish reasons.
I am more than willing to debate any skeptics of the Dynamic Investment approach at any time, in at any venue and in any format. I have the empirical data to back up my claims. Let's let an audience decide who is right. If any one wants to set up such a debate, contact me at LHevner@naoi.org and let the debate begin.
Dramatic Change Is Coming to the World of Investing
The difference between the MPT and the DIT worlds of investing is clear. The current world of investing is illustrated in the picture below at left. It is a confusing place that fosters the absolute, unquestioning dependence of investors on financial advisors who are also salespeople. In the MPT investing world people are forced to entrust their financial futures to third parties using 65+ year old portfolio design methods because they have no alternative.
The Dynamic Investment Theory-based future of investing is illustrated below at right. Dynamic Investments bypass all of the complexity that plagues the way we invest today. As explained on this site, DIs automatically change the ETFs they own in response to market changes. Thus investors can simply buy and hold them for the long-term, confident in the knowledge that their DIs are constantly monitoring market conditions and automatically making the changes needed to both grow and protect their wealth. In this new world, financial advisors have a different and more effective role as discussed at this link.
Yes, there will be skeptics of NAOI Dynamic Investment Theory and the use of Dynamic Investments. But read the above quote box again. The appearance of skeptics is a sure sign that the first stage of significant investing evolution is beginning.